Fannie and Freddie to Increase Down-Payment Requirements

The federal government is crafting a plan to phase out Freddie Mac and Fannie Mae, and it could mean higher down-payment requirements for home buyers.

Fannie Mae & Freddie Mac, in a Nutshell

Fannie Mae is the shortened name for the Federal National Mortgage Association. Freddie Mac is shorthand for the Federal Home Loan Mortgage Corporation. These two government-sponsored enterprises (GSE’s) purchase mortgage loans from lenders, and then sell them to investors. This all takes place in the secondary mortgage market — the primary mortgage market is where the loans are originated.

Fannie and Freddie were created by the U.S. government in 1938 and 1970, respectively. For the last few decades, they operated as publicly traded companies. But then in 2008, in the midst of the housing crisis, both Fannie Mae and Freddie Mac were placed into conservatorship (a form of government control).

How They Dictate Mortgage Guidelines

Fannie Mae and Freddie Mac buy mortgages from lenders in the primary mortgage market. If these primary lenders want to sell their loans, they must ensure that the loans meet certain guidelines established by Fannie and Freddie. These are referred to as conforming loans, because they conform to the established guidelines.

This is how Fannie Mae and Freddie Mac affect home buyers in the primary mortgage market. When a home buyer applies for a mortgage loan, the lender will use conforming loan criteria as an evaluation tool. These criteria include the borrower’s credit score, down payment, debt-to-income ratio and more. If the borrower meets or exceeds the minimum requirements in these areas, then he or she has a good chance of getting the loan.

In short: Borrowers who want to qualify for a mortgage in 2011 will have to meet the minimum guidelines set forth by Freddie Mac and Fannie Mae. Lenders might even impose their own guidelines on top of this.

Beginning of the End for Fannie and Freddie

The Treasury Department recently submitted a proposal for the future of Fannie Mae and Freddie Mac. The report, entitled Reforming America’s Housing Finance Market, was presented to Congress last week. Congress will weigh in on the three proposals, and then a final plan will be hammered out. Regardless of what the final option looks like, the future of Freddie Mac and Fannie Mae seems clear. The government wants to “wind down” these organizations. This could mark the beginning of the end for Fannie and Freddie.

The report’s introduction states: “The Administration will work with the Federal Housing Finance Agency (FHFA) to develop a plan to responsibly reduce the role of [Fannie Mae and Freddie Mac] in the mortgage market and, ultimately, wind down both institutions.”

Higher Down-Payment Requirements for Borrowers

The joint report from Treasury and HUD also spells out some new requirements for down payments. Specifically, they want to increase the down-payment requirements for conforming mortgage loans — loans that can be sold to Fannie and Freddie. The plan is to gradually phase in a 10-percent down-payment requirement for mortgage loans that can be sold into the secondary mortgage market.

To quote the report: “Going forward, we support gradually increasing required down payments so that any mortgage that Fannie Mae and Freddie Mac guarantee eventually has at least a 10 percent down payment.”

This means home buyers will need to put down at least 10 percent of the home’s purchase price, unless they can find a lender who is willing to offer a non-conforming loan. Most lenders adhere to the conforming loan requirements established by Fannie Mae and Freddie Mac. So the forthcoming 10-percent rule would essentially be the new norm.

The big question is, when will this happen? So far, the timeline is mostly vague. The administration wants to implement these changes gradually, at a “stable and measured pace,” as the housing market heals. When we reach this level of healing is anyone’s guess. But the writing is on the wall. The 10-percent down payment will eventually become the new norm.